Sukuk (Islamic Bonds) Under Scanner

Islamic bonds hit by scholar

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January 14, 2008

By Sebastian Abbot - MANAMA, Bahrain (AP) — The booming market for
financial products that comply with Islamic law was thrown for a loop
recently by criticism from a leading scholar, who has set off a
debate about whether the industry has sacrificed religious principles
for the sake of growth at a time of surging Middle East oil revenue.

Shariah, or Islamic law, prohibits charging or paying interest, so
bankers and lawyers have developed a rapidly growing financial market
by restructuring conventional products like bonds to make them
compliant with Islam. Shariah-compliant products attempt to replicate
the concept of interest through cost-plus transactions, leasing
arrangements or by linking payments to returns on underlying assets.
The process is normally blessed by a board of religious scholars
affiliated with a bank.

However, one of the world's leading Shariah-finance scholars recently
rattled the market by saying 85 percent of Islamic bonds, or sukuk,
are not Shariah-compliant. Sheik Mohammed Taqi Usmani argued that, in
essence, they were structured too much like conventional bonds.

Many industry participants say Shariah scholars knew the bonds had
structural issues but approved them to jump-start market growth,
raising questions about how the gatekeepers of the Islamic banking
industry weigh potential profit versus religious principles.

Others downplay the controversy, saying debate was expected, given
the rapid evolution of the market and the nature of Islamic law,
which encourages multiple viewpoints from different scholars.

The influential Shariah board headed by Mr. Usmani at the Bahrain-
based Accounting and Auditing Organization for Islamic Financial
Institutions, one of the leading groups trying to establish standards
for the market, is scheduled to meet tomorrow with the hope of
resolving the dispute and mitigating its effects on the industry.

Some say the race to expand the market has led to questionable
religious rulings — a problem that is hard to police because of the
lack of standardization across Shariah approval boards and the
shortage of Islamic scholars well-versed in finance.

"Increasing the market in volume or numbers with false product that
is against Islam is not a big success. It should be according to
Shariah, that is the main thing," said Sheik Saleh Abdullah Kamel,
chairman of the Bahrain-based General Council for Islamic Banks and
Financial Institutions, one of several organizations attempting to
monitor the industry.

Islamic banking assets outside Iran totaled $400 billion to $450
billion in 2006 and are projected to rise to $1 trillion by 2010,
according to a report by McKinsey & Co. Total assets, including those
in Iran, totaled $750 billion in 2006, a small fraction of global
financial assets, but one that is growing quickly.

Authorities say growth has been driven by booming Persian Gulf oil
revenue, Muslims' growing preference for an expanding range of
Shariah-compliant products and increasing acceptance of Islamic
banking practices by financial regulators around the world.

The development of the sukuk market has been particularly important
because there was a scarcity of Islamic products that could provide
mid- to long-term investment and potentially be traded in the
secondary market.

Sukuk issuance has grown almost 85 percent each year since 2001, with
the total value of Islamic bonds issued last year reaching $39
billion as of October, according to McKinsey.

"There has been this perception in the past that Islamic finance
doesn't lend itself to overly complicated structures, but sukuk
rebuts that view," said Nadim Khan, a Dubai-based lawyer who
specializes in Islamic banking.

"It's a real demonstration from the perspective of the Islamic
financing industry that it is possible to structure widely
acceptable, quite sophisticated Shariah compliance structures," he
added.